Chapter 3 3 1 Concert Opportunity Cost You won a free ticket to see a Bruce Springsteen concert (assume the ticket has no resale value). U2 has a concert the same night, and this represents your next best alternative activity. Tickets to the U2 concert cost $80, and on any particular day, you would be willing to pay up to $100 to see this band. Assume that there are no additional costs of seeing either show. Based on the information presented here, what is the opportunity cost of seeing Bruce Springsteen ? $20. Opportunity cost is the value of your next best alternative. In this case, your next best alternative is attending the U2 concert. Your value for this alternative is $100 with a corresponding cost of $80 leaving a net value of $20. Note: This q uestion is adapted from Paul J. Ferraro and Laura O. Taylor (2005) "Do Economists Recognize an Opportunity Cost When They See One? A Dismal Performance from the Dismal Science", Contributions to Economic Analysis & Policy : Vol. 4: No. 1, Article 7. 3 2C oncert Opportunity Cost 2 You were able to purchase two tickets to an upcoming concert for $100 apiece when the concert was first announced three months ago. Recently, you saw that StubHub was listing similar seats for $225 apiece. What does it cost you to attend the concert? What you paid three months ago is irrelevant to your costs now. The decision you are facing is to attend the concert or not. If you do not attend, you can sell the tickets for $225 (ignoring any brokering fees and hassle costs). Thus, you forego $450 to attend the concert. 3 3 Housing Bubble Because of the housing bubble, many houses are now selling for much less than their selling price just two to three years ago. There is evidence that homeowners with virtually identical houses tend to ask for more if they paid more for the house. What fallacy are th ey making? These two homeowners have virtually identical houses that should sell at virtually identical prices. The purchase price from years ago is a sunk cost and therefore irrelevant to the pricing decision. They are committing the sunk cost fallacy. 3 4 Opportunity Cost The expression “ 3/10, net 45 ” means that the customers receive a 3% discount if they pay within 10 days; otherwise, they must pay in full within 45 days. What would the seller ’ s cost of capital have to be in order for the discount to be cost justified? (Hint: Opportunity Cost) The "opportunity cost" of receiving a late payment is the foregone benefit of receiving the money early. This is determined by a firm’s cost of capital. A 3% interest rate for 35 days corresponds to an annual rate of about 3%*(365/35)=31%.
